As a colleague recently put it, PACE financing (Property Assessed Clean Energy) was the Get Out of Jail Free card of the residential efficiency market. PACE financing could have solved a number of the most persistent problems in funding residential retrofits.
Under a PACE program, a city or municipality would issue and sell bonds. They would use the revenue from the sale to lend to homeowners to finance approved efficiency projects. The city would collect payments for the loan by putting a property tax assessment on the home and the monthly payment would be added to the mortgage.
Property assessment vehicles like this are commonly used by cities when to do things like adding sidewalks to a neighborhoods, and it seemed like great way to tackle some of the tougher problems in financing residential efficiency projects.
Upfront costs too high? No problem. The PACE loan would have covered most or all of the costs of getting a project underway.
Household budget tight? No problem. The home improvements that a PACE program would finance would have saved you more in monthly energy bills than the monthly payment. Your mortgage would go up a little but your utility bills would go down by more. The homeowner saves money from day one.
Can’t borrow money at an affordable interest rate? Because PACE folds the payment into your property tax bill, which gets collected on your mortgage payment, the risk of non payment goes down and the interest rate on the loan also goes down.
These issues are precisely the ones I mentioned in my last post as posing serious obstacles to deploying energy efficiency on a large scale. PACE financing would overcome those by tying the payment to the house it improves.
And therein lies the problem. The thing that makes PACE so attractive is that the loan is ultimately secured by the value of your home, just like the money your borrowed to buy it in the first place. As you can imagine, mortgage bankers, who lent you that money in the first place are very interested in anything that might make those loans any more risky.
Because the government is very good at making sure it gets paid, if you default on your mortgage and the bank sells the home in a foreclosure sale, any property taxes you owe get paid first before the bank does.
Enter the Federal Housing Finance Authority, which among other things, oversees Fannie Mae, which in turn buys a huge amount of home loans from banks, securitizes them, and sells them on the secondary finance market. This makes Fannie Mae one of the largest mortgage holders in the country, and FHFA is in charge of keeping Fannie Mae out of trouble.
FHFA looked at PACE and saw trouble coming:
First, and most obviously, if a home with a PACE loan goes into foreclosure, any money that goes to pay off the PACE loan comes out of the money that is owed to the bank. With the housing market the way it is, many homes going into foreclosure are worth less than what’s owed on them, and mortgage holders are already losing money on foreclosure sales as it is. A PACE loan would further reduce the amount of money available to pay the mortgage holder, making lenders even worse off.
A second problem they saw was that, again with the economy and the housing market in such bad shape, adding PACE repayments to homeowners monthly mortgages might increase the probability that people would default on their mortgages. And while this ignores the fact that the whole point of the PACE program is to save homeowners money, making it easier for homeowners to take on even more debt might just be a bad idea on general principle.
It also didn’t help that there were about as many versions of PACE finance programs as there were municipalities deploying them.
For all these reasons, FHFA jumped on PACE with both feet. They issued a statement this past summer declaring the PACE financing programs violated standard mortgage agreements and instructed Fannie Mae and other mortgage lenders under its jurisdiction to use more restrictive lending guidelines in any municipality that enacted PACE legislation, even if no PACE loans have been made. This essentially killed the PACE program altogether, since anyone who used PACE financing as well as anyone in a city that had passed PACE enabling legislation would at the very least face higher interest rates for their mortgages and might not be able to get an FHFA backed mortgage at all.
Despite the fact that FHFA raised some legitimate concerns about PACE programs, many people, including me, are of the opinion that these could have been addressed through something other than the nuclear option that FHFA deployed. Had FHFA come to the table in problem-solving mode, I tend to think that some reasonable solutions could have been found, like restricting PACE financing to homeowners with enough equity in their homes to cover their mortgages plus whatever PACE would have added, plus a margin of error. Unfortunately the regulators at FHFA approached PACE as a fundamental threat to the residential mortgage market and killed it.
PACE still exists in a few places where the legislation explicitly made repayment a second priority behind the mortgage in a foreclosure sale. In these cases, since the mortgage gets paid before the PACE assessment, FHFA and the banks don’t mind so much and are willing to let it go. But of course, this undermines one of the great benefits of PACE programs in the first place, the fact that the loans are secured by the equity in the house. Home retrofit lenders don’t want to be put second in line for repayment any more than FHFA does, and in this market, being second in line provides very little security, eliminating much of the benefits that PACE programs were meant to provide, sending us back to square one.
Do not pass Go, do not collect $200.